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An essential component to maintaining strong personal financial well-being is constructing a monthly budget and operating within its confines. Though it isn’t always exciting or fun to live within the guidelines of a budget, the financial peace of mind that results from doing so is worth the effort.
However, even when we take the time and effort to construct a budget, questions can arise as to which expenses are more important than others. A good budget will show itemized monthly expense lines for all types of expenses, which can range from a necessary obligation such as housing, down to “wants” such as movie tickets and dining out.
The fact is, sometimes even a written budget can be difficult to stick to when expenses suddenly pile up from several different directions. So, how should we prioritize expenses, particularly in the midst of a difficult month? Let’s take a closer look.
Start With The 50/30/20 Rule
A proper monthly budget includes a comprehensive list of individual expenses with a calculated, accurate figure beside each individual expense. Take the necessary time to itemize properly, add everything up, and compare it to your total monthly disposable income. If you’re already beneath your level of disposable income, excellent!
However, for many people, this isn’t the case right away, and this is when the 50/30/20 rule comes into play. The 50/30/20 rule states that 50% of disposable income be allocated to necessary expenses, 30% be allocated to “wants,” and 20% be allocated to debt repayment and savings (including retirement contributions).
And here is where the need to prioritize expenses begins to come into play. Drawing a clear line between necessities and wants is important, as is keeping debt repayment and savings at 20%. This means that when necessities extend beyond 50% of disposable income, the “wants” category isn’t going to be as high as 30% that month – it’s going to be less. Remember debt repayment and savings has to stay at 20%.
Prioritize Your Necessary Expenses
Let’s take a look at the “necessary” expenses category first. These refer to recurring monthly obligations that often relate directly to physical survival. We all would agree that rent or a mortgage payment needs to be paid each month, and on time.
No need to consider this expense as optional. Another necessary monthly obligation for some that can’t be ignored each month relates to child support payments. Utility bills related to electricity and water can’t really be ignored either. Next up come things like groceries and medicine. These are obviously necessary, but differ in that they won’t have specific due dates and therefore offer some degree of purchasing flexibility within a given month.
Though medicines may offer less flexibility than groceries, both can vary by amount and timing. The same can be said for clothing purchases, which though necessary throughout the year, offer even greater flexibility and are prioritized beneath the other necessary expenses.
Recurring monthly expenses that are often considered necessary but can still be reduced include cell phone bills, internet, cable, car payments, insurance, and subscriptions such as Netflix, Hulu and a gym membership. The latter three begin to trend toward the “wants” category, which we will cover shortly.
Debt Repayment and Savings
Let’s jump to this category next, as it is almost as important as necessary expenses related to survival. Remember – according to the 50/30/20 rule, there is zero flexibility in terms of the 20% of monthly disposable income that must be allocated to debt repayment and savings – including retirement savings.
Any outstanding credit card debt needs to be paid off in a timely manner each month, ideally in full, but certainly at a level greater than the minimum monthly payment if economically feasible.
There is no greater short-circuit to financial well-being than carrying an insidious pile of high interest rate credit card debt that accumulates high levels of interest expense on a continual monthly basis. Equally important and often overlooked, is to contribute toward retirement savings.
Some employers offer IRA matching contributions that should absolutely be fully utilized, even if the idea of retirement seems too remote to actually matter. Fact is, the future has a nasty habit of arriving ahead of schedule, and for some people, unexpected health predicaments can force an early retirement.
Better to be prepared than to be caught off guard. Speaking of which, it is also important to save for an emergency fund – at the minimum $1,000 – $2,500 – though a true emergency fund to cover for a job loss should include three to six months of budgeted living expenses.
Think of an emergency fund as insurance for the unexpected – sudden health expenses or auto/home maintenance repair bills can easily occur – and an emergency fund provides peace of mind along with a cushion that can keep you from relying on a credit card when the unexpected happens.
Wants
The “wants” category expenses are the fun stuff – restaurant meals, movies, concerts, electronics, vacations, etc. Though these are nice to have, that’s exactly how they need to be considered – nice to have.
When all necessary expenses and debt repayment/savings have been allocated, whatever amount of disposable income that remains can be allocated here. For single people – particularly those living in an urban environment where a car may not be necessary – it can be easier to have a generous allocation of wants that meets or even exceeds 30% of disposable income.
Fact is, single people have far fewer necessary expenses. Housing, groceries and transportation for a single person will often be be less than for an individual with, let’s say, two dependents. A married couple with a child and a spouse who may be at home taking care of the child (not working) will have a greater amount of necessary expenses that can cut into the freedom to spend within the wants category.
Housing, transportation, clothing, food, utilities, saving for retirement and a child’s college education…there’s little room for maneuvering here when a small family is involved. But for a single person who likes to go out and doesn’t have to worry about supporting others and providing higher education to a child, there’s far more latitude in the budget for wants.
Regardless, when it comes to prioritizing expenses, “wants” should always be situated at the low end of the totem pole.
About The Author: Steven Brachman
Steven Brachman is the lead content provider for UnitedSettlement.com. A graduate of the University of Michigan with a B.A. in Economics, Steven spent several years as a registered representative in the securities industry before moving on to equity research and trading. He is also an experienced test-prep professional and admissions consultant to aspiring graduate business school students. In his spare time, Steven enjoys writing, reading, travel, music and fantasy sports.